Amazon's founder, Jeff Bezos, has always taken a keen interest in tax planning. From the beginning, loopholes were a key part of Amazon's ability to undercut rivals on price. When setting up the company, Bezos even considered basing it on an American Indian reservation near San Francisco to exploit state tax loopholes.

The world's largest internet retailer collects sales taxes from only five American states, exploiting a 1992 court ruling that US businesses without a physical presence – such as a shop or warehouse – in a state cannot be required to collect its sales tax. Amazon has a map of the US with each state coloured red, yellow or green. Executives travelling to red states need company permission before entering, in case their actions trigger laws that force Amazon to collect taxes there.

Amazon's UK managing director, Christopher North, said in a recent radio interview that while the company benefits from low corporation tax by being based in Luxembourg, it pays Britain's 20% value added tax rate.

"The products we sell and ship to customers we pay the UK VAT rate," said North.

But he conceded that this only applies to physical products – and books are zero-rated. Tax on ebooks is at the rate set by Luxembourg, which has defied European guidance. Instead of charging tax at the national VAT rate, it takes only 3%, on the grounds that, like printed books, electronic publications are of cultural significance.

This matters because sales of ebooks are soaring. Worldwide, Amazon now sells 115 ebooks for every 100 paperbacks. About 1.3m ereaders were bought in the UK this Christmas, according to pollster YouGov, and 95% of them were Kindles made by Amazon.

In the UK, trade title the Bookseller estimates that Amazon controls at least 70% of the ebook market, which will be worth an estimated £500m in 2012, up from £150m last year.

The British government is being lobbied to lower VAT on ebooks to zero, in line with printed titles, which are sold free of tax. "This is the year to get VAT sorted," says the Bookseller's deputy editor, Philip Jones. "In 2012 it becomes a big number that is handed over to the Treasury, or not, in Amazon's case."

A zero rate would overnight hand British retailers such as Waterstones and smaller independent bookshops a 3% price edge on Amazon and the second largest UK ebook seller, Apple's iTunes, which also has its European headquarters in Luxembourg.

Amazon was founded in 1995 as an online bookstore, but "media" sales have formed the smaller slice of its revenues since 2010. Last year, worldwide media sales grew 20% to $17.8bn (£11.2bn), but sales of other merchandise were up a staggering 56% to $28.7bn. It now makes more money from selling a panoply of nappies, TVs and golf clubs than it does from reading material, videos and music.

Amazon has used acquisitions to diversify, spending $540m on baby supplies store diapers.com, snapping up America's largest shoe etailer, Zappos, and Woot, a site offering daily deals on everything from T-shirts to wine.

Diversification has had spectacular results. Net sales rose 41% to $48bn in 2011. Amazon now has 164 million active registered account holders. Even its sideline data-hosting business – renting out server space to other firms – is one of the world's largest.